What is IRR? What does it mean in making investment decisions. As a wise trader or investor, you cannot ignore the investment index. One of the indicators that cannot be ignored is the IRR. So what is IRR really. What is the role and importance of it? The calculation of the IRR index.
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What is IRR?
IRR is the internal rate of return. This is the rate of profit of the business, used for budgeting, to evaluate the efficiency of business investment.
It is the rate of return of the investors, when they invest in the field, the effect they get. In today’s economic context, IRR can also be considered as the effective interest rate of investment.
However, this ratio when determined does not depend on environmental factors. Some environmental factors affecting business results are interest rates, inflation, other economic ratios, …
IRR rate is directly related to the return investors receive after each investment transaction.
What is the meaning of the IRR Index
The higher the IRR of the internal rate of return, the higher the project’s viability. If the IRR is low, the opposite is true.
If this value is greater than the discount rate then the project is evaluated.
IRR rate is used to measure and arrange projects according to prospects in order. From the information it is easy to consider which projects to invest in. The rate of IRR due to the growth rate of a project is generated.
If the elements of the projects are the same, the project with a high IRR is the top priority.
The IRR rate is a tool that helps investors to focus their full efforts on this project or many other projects.
If comparing the IRR rate with the rate of return on the stock market. If a company does not have higher IRR rate in the market. Simply invest your money in the market instead of doing the project.
1. Some of the roles of the IRR are:
Project has an IRR greater than the limit of financial feasibility limit
For projects with a low feasibility rate, it is possible to choose the project with the highest IRR.
2. Advantages of IRR rate:
Easy to calculate because it does not depend on the cost of capital, it is very convenient for comparing investment opportunities. Because this ratio indicates profitability.
Suggestions for the interest rate selection for the project, the IRR may indicate the highest interest rate that the project can accept.
3. Disadvantages of IRR rate:
It takes a lot of time to calculate this indicator
For projects with large net profit margin based on IRR index only.
It is difficult to determine the IRR rate if the investment project is supplemented, the NPV changes a lot.
How to calculate the IRR
This rate is expressed as the interest rate. If an IRR converted to a project’s cash flow is used, the actual present value of income equals the present value of the execution.
r1 is the smaller discount rate
r2 is the larger discount rate
NPV1 is the net present value which is a positive number but close to 0 calculated in terms of r1
NPV2 is the net present value which is a negative number but close to 0 calculated in r2
Relationship between IRR AND NPV
IRR index is determined in%, NPV is determined by amount.
If the same data are included, there are many cases where the IRR is not as valid an indicator to evaluate the project as the NPV. IRR rate is a common evaluation index for many projects.
A simple indicator or tool can evaluate many projects. Not requiring too much engineering and time, the IRR indicator is a very affordable tool.
With a volatile market, this index does not show that volatility. In some cases, this indicator is not suitable for calculation.
NPV index, you can determine in an easy, simpler way. For projects, this index only needs to be greater than 0 for the project to be profitable.
See also: What is NPV? Formula for calculating NPV
With the article on what is an IRR, you should also have an idea of the IRR which is one of the tools that can help administrators to evaluate project effectiveness. However, in evaluating the effectiveness of the project, investors should consider additional indicators. Let’s explore more other indicators for a more comprehensive view.